The Time for Growth Stocks Is Near

Jim Oberweis, president of Oberweis Asset Management and editor of the Oberweis Report, thinks we're at an inflection point where growth stocks will begin to outperform value.

Value investing has been hotter than the top of Mount Vesuvius in Pompeii on August 24, 79 A.D. Since the tech crash of 2000, value stocks have trounced growth stocks. The Russell 2000 Value Index returned 109% versus 26% for the Russell 2000 Growth Index from 2001 through the first quarter of 2007. Money has poured into value funds since 2001, which has just fueled the fire for the value rally.

The trouble with Pompeii, of course, is that the party didn't last. The volcano erupted and it wasn't a pretty picture afterward. While many remember the destruction of Pompeii nearly 2000 years ago, it seems the market has forgotten the last stock market bubble only seven years ago. Then it was value stocks that were unloved, while growth stocks were all the rage.

Between 1995 and 1999, growth stocks returned twice as much as value stocks. The Russell 2000 Growth Index returned 181% versus 84% for the Russell 2000 Value Index in this period. Legendary value manager Julian Robertson of the Tiger Fund called it quits. Stanley Druckenmiller of the notable Quantum Fund stepped out. Nicolas Roditi of the London-based Quota Fund, which had lost a third of its value by the end of April 2000, made his exit.

Many other value managers followed suit. In retrospect, just when it seemed that value's demise was near, the contrary could not have been truer. Early 2000 would later be recognized as the peak of the growth stock bubble and the beginning of a boon for value investors.

Today the tables are turned. Growth is undervalued and value stocks are dangerously expensive. I'd argue that the evidence is clear that we are nearing-and maybe even have passed-an inflection point once again. Those who believe in the law of mean reversion should buy growth stocks today; indeed, value leadership appears to be waning. In a notable change, small-cap growth returns are leading value by about 250 basis points so far in 2007.

Frankly, that makes a lot of sense to us. The value creed is to buy asset-rich stocks on the cheap. But value stocks just aren't cheap today, particularly not in relation to growth stocks. Due to the recent popularity of value investing, value stock prices have been driven up, and the "premium" required to buy growth stocks is smaller than ever.

Our message this month should be very clear: The time for growth is near. While it's impossible to pick the exact inflection point in advance, we believe small-cap growth stocks are highly likely to outperform small-cap value stocks over the next three years. And remember, when a small-cap growth rally begins in earnest, stocks such as those [we look at] tend to really shine.